While dabbling in the dark arts of economics myself, I am certainly no Nobel Laureate; indeed I have a tough time even spelling “Laureate”. That said, in the earliest days of this website (2007) I wrote one of the most popular entries – Do The Bottom 80% of Americans Stand a Chance? (see here). While that was still early in the housing crisis and part of the piece focused on the damage that was to come due to the reliance on the home equity ATM, much of the piece was devoted to structural changes happening in terms of globalization, inflation, wage stagnation, and the growing income inequality. A few years later (2009) I found a research report by Citigroup describing America as a “Modern Day Plutonomy” (see here)
In a “plutonomy”, according to Citigroup global strategist Ajay Kapur, economic growth is powered by and largely consumed by the wealthy few.
There have been quite a few other stories along the way, but the reality is in return for cheaper prices, many Americans – especially in the lower 2/3rds – have lost a grip on what used to be a middle class lifestyle. We still seem to be in denial about this, and frankly even if we were not still in the denial stage, finding solutions would be extremely difficult. As investors we need to focus on the reality of what is… and in the U.S. that means a barbell approach – focus on companies serving the top end, and the low end – as the middle is being hollowed out. And as I often write, this is not bad for “humankind” as many in relatively poor countries now move up the food chain – but not without a cost for those in relatively rich countries.
The most excellent journalist Cynthia Freeland highlighted a paper – The Evolving Structure of the American Economy and the Employment Challenge – by Nobel Laureate Michael Spence, which essentially comes to the same conclusions I’ve been writing about for nearly 4 years. She declares (or her headline writers declares!) ‘Capitalism is Failing the Middle Class’. It is definitely an interesting read for those interested on the topic, so I thought I’d highlight it. The variance between the tradable sector (i.e. areas that jobs that can be outsourced) versus nontradable is striking, but we’ve discussed that in length before as all the net job growth in the country of late has been in government, healthcare, and education – the latter two heavily supported by taxpayer, and impossible to outsource en masse.
PDF file for the original paper.
This Working Paper by Nobel Laureate Michael Spence and Sandile Hlatshwayo is a detailed examination of the changing shape of the American economy and the effect of these changes on the labor market and the cost of goods. Spence and Hlatshwayo focus on trends in value added per employee in the tradable and nontradable sectors over the past twenty years.
They note that the American economy has seen the lower and middle components of the value-added chain moving to the rapidly growing markets abroad and warn that soon higher-paying jobs may follow low-paying jobs in leaving the United States.
The actions of the free market have made goods less expensive for Americans, but the free flow of labor and capital has also diminished the employment opportunities available in the United States and will, the authors warn, continue to do so at all levels of society. Spence and Hlatshwayo suggest that policymakers acknowledge the trade-off between the cost of goods and the availability of jobs, and they explore policies that may improve it. While the authors acknowledge that there is no simple policy fix to improve the trade-off between inexpensive goods and diminished domestic job opportunities, they argue that given the political salience of the issues at stake, policymakers must work to tackle this enormous question of inequality and economic distribution.
Here is Cynthia’s take on the subject:
- Global capitalism isn’t working for the American middle class. That isn’t a headline from the left-leaning Huffington Post, or a comment on Glenn Beck’s right-wing populist blackboard. It is, instead, the conclusion of a rigorous analysis bearing the imprimatur of the U.S. establishment: the paper’s lead author is Michael Spence, recipient of the Nobel Prize in economic sciences, and it was published by the Council on Foreign Relations.
- Spence and his co-author, Sandile Hlatshwayo, examined the changes in the structure of the U.S. economy, particularly employment trends, over the past 20 years. They found that value added per U.S. worker increased sharply during that period – 21 per cent for the economy as a whole, and 44 per cent in the “tradable” sector, which is geek-speak for those businesses integrated into the global economy. But even as productivity soared, wages and job opportunities stagnated.
- The take-away is this: Globalization is making U.S. companies more productive, but the benefits are mostly being enjoyed by the C-suite. The middle class, meanwhile, is struggling to find work, and many of the jobs available are poorly paid.
- Spence is neither a protectionist nor a Luddite. He prominently notes the benefit to consumers of globalization: “Many goods and services are less expensive than they would be if the economy were walled off from the global economy, and the benefits of lower prices are widespread.” He also points to the positive impact of globalization on much of what we used to call the Third World, particularly in China and India: “Poverty reduction has been tremendous, and more is yet to come.”
- Spence’s paper should be read alongside the work that David Autor, an economist at the Massachusetts Institute of Technology, has been doing on the impact of the technology revolution on U.S. jobs. In an echo of Spence, Autor finds that technology has had a “polarizing” impact on the U.S. work force – it has made people at the top more productive and better paid and hasn’t had much effect on the “hands-on” jobs at the bottom of the labor force. But opportunities and salaries in the middle have been hollowed out.
- Taken together, here’s the big story Spence and Autor tell about the U.S. and world economies: Globalization and the technology revolution are increasing productivity and prosperity. But those rewards are unevenly shared – they are going to the people at the top in the United States, and enriching emerging economies over all. But the American middle class is losing out.
- To Americans in the middle, it may seem surprising that it takes a Nobel laureate and sheaves of economic data to reach this unremarkable conclusion. But the analysis and its impeccable provenance matter, because this basic truth about how the world economy is working today is being ignored by most of the politicians in the United States and denied by many of its leading business people.
- Spence says that as he was doing his research, he was often asked what “market failure” was responsible for these outcomes: Where were the skewed incentives, flawed regulations or missing information that led to this poor result? That question, Spence says, misses the point. “Multinational companies,” he said, “are doing exactly what one would expect them to do. The resulting efficiency of the global system is high and rising. So there is no market failure.”
- This conclusion is a very big deal – Spence is telling us that global capitalism is working the way it should, but that the American middle class is losing out anyway. Since global capitalism is the best way we’ve come up with so far to run our economy, that creates quite a dilemma.
- Spence is honest enough to admit that he has no easy answers. But he has posed the right question. American politicians in both parties are focused on a budget debate that is superficial, premature and ultimately about something pretty easy to figure out. Instead, we should all be working on the much bigger problem of how to make capitalism work for the American middle class.